Taking Outsized Risks for Undersized Rewards!

Typically we’d view a low yield spread between high yield (junk) bonds and high quality (investment grade) bonds as a positive sign with regard to present general conditions. Of course context is everything!

Per our recent messaging, which is overwhelmingly confirmed by the latest numbers, the record stretch of low interest rates we presently operate under has inspired — if not demanded — investors to seek yield wherever they can find it. 

The green line below tracks the difference in yield between BB-rated (junk) corporate bonds and BBB-rated (investment grade) corporate bonds (the BB/BBB spread), the white line tracks the S&P 500 Stock Index. The shaded rectangles capture periods where the BB/BBB spread meaningfully bottomed to where it ultimately topped. The shaded circle highlights the current spread. Red shaded areas highlight past recessions. Note the movement in the S&P 500 Index during each bottom-to-top occurrence. 

Bottom line: Folks are willing to take outsized risks to capture undersized rewards. Historically-speaking, it can get ugly when they wake up…


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